"The sooner you start saving, the more time your money has to grow."
This popular wisdom is the basis of one of the key pillars of finance: Having a dollar today is more valuable than having a dollar in one year, simply because I can invest the dollar today and earn interest on it. The purpose of this module is to understand the key issues surrounding this "Time Value of Money." We learn how to compute the future value of investments that we make today, and we see how to determine the present value of payments that we expect to receive in the future. Moreover, we look at important shortcuts in the valuation of simple investment projects such as perpetuities and annuities. While the module is rather technical, it provides indispensable skills that are relevant for virtually anything we do in finance.
How to determine whether an investment makes financial sense or not? This module introduces the most important investment decision criteria that try to answer this question. The basic idea is very simple: Investors like projects that make more money than they cost!
We start with the Net Present Value (NPV) rule, wich measures the difference between the present value of all cash inflows and the present value of all cash outflows that are associated with an investment decision. We show that managers who follow the NPV rule and accept only projects with positive NPV generally increase the financial value of the firm.
We also discuss other approaches to measure the difference between the costs and benefits of a project, in particular the Internal Rate of Return (IRR), which indicates which return an investor can expect by investing in a project, and Payback rule, which shows how long it takes for a project to return the invested capital. While both metrics have their justifications, NPV generally does a better job.
In this module, we learn how to estimate project cash flows. The relevant cash flow is the so-called net cash flow (NCF), which indicates how much money a project is expected to generate for the providers of capital. The estimation of the relevant cash flows is arguably the most important step in any capital budgeting exercise.
The module first explains in detail what NCFs are and what basic rules we have to remember when estimating the NCFs of projects. In the process, we learn how to compute Incremental Net Cash Flows and we practice this knowledge with a number of examples and case studies. The module then shows how to make sure that we treat inflation in a consistent way. Finally, we discuss how to include important non-financial goals, such as environmental, social, and governance (ESG) factors into our considerations, using a so-called Adjusted Present Value (APV) approach.
The purpose of this module is to learn how to estimate risk-adjusted discount rates to value projects (or firms). It takes us on a journey with many important steps. First, we have to understand what "risk" actually means and how the relation between risk and return can be formulated. To find the necessary answers, the first major block of this module introduces the basic principles of portfolio theory. The second part of the module then shows how to use the insights from portfolio theory to derive discount rates. To this end, we present the Capital Asset Pricing Model (CAPM), which formalizes the relation between return and risk, and we show what practical steps are relevant to get to what we ultimately want: A discount rate to estimate project or firm value, the so called Weighted Average Cost of Capital (WACC).